Question

Look for the economic news on both Japanese and Australian economies and any anticipated changes in the interest rates by their central banks. Do you think the Australian dollar will appreciate or depreciate against the yen next month? Explain why.

Answer 1

Australia’s central bank may cut interest rates on Tuesday after holding the rate flat for over two years.

For the first time since Philip Lowe’s appointment as governor in 2016, the Reserve Bank of Australia (RBA) is expected to lower its cash rate by a quarter point to a record low of 1.25 per cent, according to 14 of 26 economists surveyed by Bloomberg. The remaining 12 said they expected the RBA to leave the rate unchanged at 1.5 per cent.

After leaning towards a tighter policy only a few months ago, the RBA is now tilting marginally towards easing. The key trigger was a change in the policy stances of the US Federal Reserve and the Bank of Canada – two central banks the RBA watches more closely than others.

The Bank of Japan has promised not to raise interest rates before spring 2020 as it made a series of tweaks to its massive programme of monetary stimulus. It is the first time Japan’s central bank has put a date on the “extended period” for which it intends to keep rates low, mirroring a policy first used by the US Federal Reserve in 2011. A specific date gives markets greater certainty but with almost nobody expecting a rate rise during the next year, it is unlikely to make a substantial difference to the economy. The BoJ’s decision, however, shows it is concerned about slowing growth and the lack of progress towards its 2 per cent inflation objective. The underwhelming scale of the action may only add to the perception that it has run out of ideas and tools for stimulus.

Over the past couple of months, the Australian dollar has depreciated by about 4 per cent on the basis of the trade-weighted index (TWI). This largely reflects the effect of the appreciation of the yen and the renminbi, which collectively comprise nearly 40 per cent of the TWI. The yen appreciation may have been driven by the tendency of Japanese investors to bring some of their funds back home during ‘risk-off’ periods in global financial markets.

The decline in Australian bond yields relative to other advanced economies is likely to have contributed somewhat to the modest depreciation of the Australian dollar of late. However, over much of the past 18 months or so, higher commodity prices appear to have worked to limit the extent of Australian dollar depreciation. Indeed, commodity prices have increased noticeably of late. This largely reflects disruptions to supply, particularly of iron ore. In short, there are a number of forces affecting the Australian dollar, but they have been pulling in different directions. Accordingly, the Australian dollar remains within its relatively narrow range of the past few years.